In previous post, we discussed about how you determine the value of stock under Dividend growth model. In this post, we will discuss how you can value stock when the growth rate is not stable and changes from year to year.
Example
ABCSoft is in the phase of rapid growth. The dividend for the next two years are expected to grow @ 12% . In the third year, the dividend will grow @ 14 %. After that, dividend is expected to grow at the constant rate of 5 %. ABCSoft has just paid a dividend of $ 1.20 per share. The required rate of return is 10 %. Find out the price of the stock today using the supernormal growth valuation method.
Answer
| Period | Dividend | Calculation | Amount | Present Value |
| 1.000 | D1 | 1.20 x 1.12 | 1.344 | 1.222 |
| 2.000 | D2 | 1.20 x 1.12^2 | 1.505 | 1.368 |
| 3.000 | D3 | 1.50528 x 1.14 | 1.716 | 1.560 |
| 4.000 | D4 … | 1.716019 x 1.05 | 1.802 | – |
| – | – | 1.80182 / (0.10 – 0.05) | 36.040 | – |
| – | – | 36.04/1.10^3 | – | 27.077 |
| – | – | – | – | – |
| – | – | – | – | – |
| – | – | Value of stock today = | 31.228 |